Sovereign wealth funds conjure up images of Middle Eastern countries buying U.S. companies or China making a grab for resource stocks.
They certainly stir up anxiety – one reason for the U.S. to dust off rules on foreign ownership that had lain dormant for decades.
But is the worry merited? Do sovereign wealth funds act any differently than other corporations making mergers and acquisitions?
Andrew Karolyi, who holds the Alumni Chair in Asset Management at the Johnson Graduate School of Management at Cornell University, suggests no. He presented his findings in Toronto this week as part of a investment forum sponsored by Dimensional Fund Advisors.
It’s important to define just what sovereign wealth funds are. They are state investment vehicles that recycle currency reserves accumulated through a favourable balance of trade. Some derive from oil wealth, such as those in Abu Dhabi (Abu Dhabi Investment Authority), or Norway’s sovereign wealth fund. Others, such as China (China Investment Corporation) and Singapore (Temasek Holdings), have grown their currency reserves through the merchandise trade. Together, they control $3.2 trillion in assets. Those current account balances lead, Karolyi says, “a giant war chest.”
But sovereign wealth funds are not the only sovereign acquirers. There are also publicly listed but state-majority owned companies in such places as Japan (Japan Tobacco), France (EDF, an electrical utility), Dubai (Dubai Ports) and China (CNOOC). Hence Karolyi uses the term “sovereign acquirer” rather than sovereign wealth fund.
In a working paper written with Rose Liao , Karolyi examined 5,317 cross-border deals over the past 20 years, with a value of $620 billion. To shed light on the behaviour of sovereign acquirers, they compared those transactions with 150,379 acquisitions made by corporations in the same period. They examined deals in which the acquirer sought at least 5% ownership
They posed four questions: do sovereign acquirers target specific countries; do they focus on specific kinds of firms; do stockholders react negatively; and finally, does a purchase make a difference to the company’s fundamentals.
These are worthwhile questions, especially since the pace of sovereign acquisitions has significantly quickened in the past two years.
But, for each question, while there are some differences, they are not statistically significant. Or as Karolyi says, “the explanatory power is horrible.”
The largest acquirers were China, France and Singapore. The largest target countries were the U.S., the U.K., Hong Kong and Australia. China targets developed Asia for deals. But the bulk of that is in Hong Kong. France plays in Europe. Sovereign acquirers, it seems, “like to shop close by,” Karolyi reports.
But so do non-sovereign corporations.
The same pattern is replicated with types of companies: sovereign and corporate acquirers show little difference in whether they are taking stakes in larger companies versus smaller companies, or in companies that are having capital difficulties versus those that are not.
Nor do share prices show any marked difference once a deal is announced. It doesn’t matter who the acquirer is.
Finally, there is no evidence of a difference in company performance after an acquisition is made, whether it’s profitability or increased sales or more capital spending.
Still, Karoyli maintains, “non-results are very important.” With Dimensional Fund Advisor’s research work, such non-results often occur. “A negative result is still a valid result,” says Dimensional vice-president of research Jim Davis. Dimensional has a number of research endeavours in progress.
For example, when some securities evince higher costs than others in the securities lending market, that may indicate that the short-sellers have specific information, since they are willing to pay more to borrow the stock. But that also suggests that Dimensional traders should hold off for a few days before buying the stock, since the five-day returns tend to be “not so good.”
Another research study focuses on weighting stocks according to their country’s GDP. That would have been beneficial over time, since it would have missed the Japanese bubble captured by weighting stocks according to market cap. Was that a one-time only effect? Well, consider emerging markets. Cap-weighting may underweight countries with less-developed capital markets that are showing significant growth.
Then there’s the liquidity premium. Some sellers want immediate execution, Davis suggests, because “information has a short life.” They may know something about the company that the market, in general, doesn’t. At the same time, someone willing to wait until a seller hits the bid price can earn a premium.
One of the more interesting research results was provided by Bob Deere, investment director at Dimensional. In the Dimensional framework, guided by Eugene Fama and Kenneth French’s three-factor methodology, certain risks are rewarded: market risk, value risk (as against growth) and small-company risk (as against larger, more liquid companies).
But there’s an anomaly among small companies. Some small-cap growth companies don’t seem to outperform large-cap growth companies. Dimensional is now culling 293 small-cap growth companies – about 10% of assets – from its small-cap portfolios, based not only on their book-to-market size, but their earnings-to-price and cash-flow-to price ratios.
That’s what the numbers tell Deere. The actual explanation for the underperformance is an open question. Deere suggests it may be due to a high concentration of small pharmaceutical companies with drugs in the pipeline.
But more research – with positive or negative results – is the order of the day.